Friday, June 25, 2010

Big Revenue Recognition Changes to Come

FASB and the IASB yesterday released a proposed accounting standard that would create one harmonized revenue recognition standard for both U.S. GAAP and IFRS.

The standard claims to simplify and standardize accounting for revenue across industries and update standards to remedy inconsistencies in current standards and practices.

In keeping with the general thrust of principles-based standards, the new proposal will require more disclosures.

The proposal also includes guidance to clarify accounting for contract costs.

On its release, the proposal was cited as one of the most important and pervasive areas in financial reporting.

According to the IASB, the proposed standard “would make it absolutely clear when revenue is recognized—and why.” The core principle was explained as “a company should recognize revenue when it transfers goods or services to a customer in the amount of consideration the company expects to receive from the customer.”

The standard is expected to impact some long-term contracts, especially those using percentage-of-completion revenue recognition.

Significant changes:
1. Revenue would be recognized only from the transfer of goods or services to a customer.
2. A company would be required to account for all distinct goods or services, which could require it to separate a contract into different units of accounting from those identified in current practice.
3. Collectibility would affect how much revenue is recognized, rather than whether revenue is recognized.
4. Greater use of estimates would be required in determining both the amount to allocate and the basis for that allocation, which would better reflect the economics of a transaction.

FASB also created a chart showing the five steps a company would follow to apply the new revenue recognition proposals; see below.

The proposal is intended to apply to all contracts to provide goods or services to customers, except leases, insurance contracts and financial instruments.

Disclosures that are new under the proposal include qualitative and quantitative information about contracts with customers, including a maturity analysis for contracts extending beyond a year, and the significant judgments and changes in judgments made in applying the proposed standard to those contracts.

The deadline for comments on the proposal is Oct. 22. The final standard is expected in the second quarter of 2011. The modified convergence timeline keeps the June 2011 target end date for projects that have the most urgent needs.

Click for the full proposal or the overview and here for the podcast.

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